Portfolio Rebalancing for Dummies

If you have been putting off, or can’t bear the thought of, rebalancing your portfolio, here are three ways to make the process simpler and, perhaps, more tolerable.

Rebalancing your holdings—and, ideally, reducing the level of volatility in your savings—is frequently a difficult exercise. It’s hard to sell assets that have been performing well because we tend to assume they will continue to perform well. And it’s difficult to buy into assets that seem problematic. (Think: bonds, where yields are all but nonexistent.)

With that in mind, in a recent article on Morningstar.com, Christine Benz, director of personal finance, offers three possible strategies for investors who are wary of going “all in” on rebalancing, but wish to capture some of its risk-reducing benefits. She calls them “chicken” ways of rebalancing.

“Bear in mind,” Ms. Benz notes, “that the ‘chicken’ methods won’t yield the same risk-reduction benefits. Thus, these strategies—especially the first two—will tend to be the best fit for those with longer time horizons and/or higher risk tolerances.”

Redirect new contributions

Beyond the mental gymnastics involved in rebalancing, the process can involve costs—both transaction costs and possible taxes from capital gains (if you’re rebalancing in a taxable account). One solution: Skip the selling piece of rebalancing and, instead, use future contributions to help restore balance.

“Right now,” Ms. Benz writes, “investors who would like to give their portfolios a contrarian tilt might curtail new purchases of U.S. equity holdings and instead direct new contributions to bonds, international equities and cash.”

Practice intra-asset-class rebalancing

Let’s say your target allocation for stocks is 60%—but that figure has drifted up to 70%. Here, Ms. Benz notes, you could “scale back on areas that may be notably overvalued while adding to potentially undervalued categories.”

Example: Growth stocks have generally outperformed value stocks in recent years, which means they could be hit harder in a sell-off. So, decreasing the former and adding to the latter could be a way to take some risk off the table.

Delegate

If the very idea of rebalancing is intimidating, delegate some of the work. Target-date funds, for instance, involve built-in rebalancing, with a gradual shift to a more conservative portfolio mix. Or…many 401(k) plans offer an automatic rebalancing feature, where asset classes are periodically restored to their target level.

No, rebalancing isn’t a guarantee of higher returns. But research indicates that investors can “reduce their portfolios’ future volatility levels by scaling back on highly appreciated asset classes and adding to the losing ones,” Ms. Benz writes. “And limiting volatility —and avoiding bum “sequencing risk” (that is, encountering lousy returns in the early retirement years) —should be top of mind for retirees.”